What is Rule 144A?
Rule 144A is a safe harbor exemption from the registration requirements of Section 5 of the Securities Act for certain offers and sales of qualifying securities by certain persons other than the issuer of the securities. The exemption applies to re-sales of securities to qualified institutional buyers, who are commonly referred to as “QIBs.” QIBs must be institutions, and cannot be individuals—no matter how wealthy or sophisticated. The securities eligible for resale under Rule 144A are securities of U.S. and foreign issuers that are not listed on a U.S. securities exchange or quoted on a U.S. automated inter-dealer quotation system. Rule 144A provides that reoffers and re-sales in compliance with the rule are not “distributions” and that the reseller is therefore not an “underwriter” within the meaning of Section 2(a)(11) of the Securities Act.
A reseller that is not the issuer, an underwriter, or a dealer can rely on the exemption provided by Section 4(1) of the Securities Act. Resellers that are dealers can rely on the exemption provided by Section 4(3) of the Securities Act. Rule 144A modifies the Securities and Exchange Commission (SEC) restrictions on trades of privately placed securities so that these investments can be traded among qualified institutional buyers, and with shorter holding periods—six months or a year, rather than the customary two-year period. While the Rule, introduced in 2012, has substantially increased the liquidity of the affected securities, it has also drawn concern that it may help facilitate fraudulent foreign offerings and reduce the range of securities on offer to the general public. Rule 144A is designed to provide an exemption to the general rule that all securities must be registered with the SEC before being sold. The rule specifically addresses the resale of securities among what the rule calls qualified institutional buyers, which includes most categories of institutions that qualify as accredited investors under the securities laws.
Individual investors cannot be qualified institutional buyers; only institutions qualify under Rule 144A. The general intent of the rule is to allow institutions to engage in transactions the SEC would deem too risky for the general public. Institutions can make trades even though the underlying issuer hasn’t provided the full information required for SEC registration. The assumption is that large institutions are savvy enough to do their own due diligence without the SEC backing them up, in contrast to individual investors, who typically lack the resources to verify claims from issuers without the agency’s help. In addition, Rule 144A has made the markets for privately placed restricted securities more liquid than they would otherwise be. Ordinarily, a two-year holding period applies under SEC Rule 144 to institutions that buy restricted securities from issuers. By allowing trades among qualified institutions, Rule 144A allows shorter-term investment in these securities.
Who may rely on Rule 144A?
Any person other than an issuer may rely on Rule 144A. Issuers must find another exemption for the offer and sale of unregistered securities. Typically, they rely on Section 4(2) (often in reliance on Regulation D) or Regulation S under the Securities Act. Affiliates of the issuer may rely on Rule 144A.
What types of transactions are conducted under Rule 144A?
The following types of transactions often are conducted under Rule 144A:
• offerings of debt or preferred securities by public companies; offerings by foreign issuers that do not want to become subject to U.S. reporting requirements;
• and offerings of common securities by non-reporting issuers (i.e., “backdoor IPOs”).
Rule 144A program
An issuer that intends to engage in multiple offerings may have a Rule 144A program. Rule 144A programs are programs established for offering securities (usually debt securities) on an ongoing or continuous basis to potential offered. They are similar to “medium-term note programs,” but they are unregistered, and the securities are offered only to QIBs. These programs often are used by financial institution and insurance company issuers to offer securities, through one or more broker-dealers, to institutional investors in continuous offerings.
The Impetus for Rule 144A
Before a security can be offered to the general public, the Securities Act of 1933 stipulates that the issuer must register it with the SEC and provide extensive documentation through a filing with the agency. Rule 144A, however, was drawn up in recognition that more sophisticated institutional investors may not require the same levels of information and protection as do individuals when they buy securities. The Rule provides a mechanism for the sale of privately placed securities that do not have—and are not required to have—an SEC registration in place, creating a more efficient market for the sale of those securities.
Rule 144A Holding Requirements
In addition to not requiring that securities receive SEC registration, Rule 144A relaxed the regulations over how long a security must be held before it can be traded. Rather than the customary two-year holding period, a minimum of a six-month period applies to a reporting company, and a minimum one-year period applies to issuers not required to meet reporting requirements. These periods begin on the day the securities in question were bought and considered paid in full.
What securities are eligible for exemption under Rule 144A?
Securities offered under Rule 144A must not be “fungible” with, or substantially identical to, a class of securities listed on a national securities exchange (which includes the NASDAQ Market System) or quoted in an automated inter-dealer quotation system (“listed securities”). Common stock is deemed to be of the “same class” if it is of substantially similar character and the holders enjoy substantially similar rights and privileges. American Depositary Receipts (“ADRs”) are considered to be of the same class as the underlying equity security. Preferred stock is deemed to be of the same class if its terms relating to dividend rate, liquidation preference, voting rights, convertibility, call, redemption, and other similar material matters are substantially identical. Debt securities are deemed to be of the same class if the terms relating to interest rate, maturity, subordination, convertibility, call, redemption, and other material terms are substantially the same. A convertible or exchangeable security with an effective conversion premium on issuance (which means at pricing) of less than 10%, and a warrant with a term less than three years or an effective exercise premium on issuance (at pricing) of less than 10%, will be treated as the “same class” as the underlying security.
What is a 144A Bond Offering?
144A bonds fall under “Rule 144A”. The 144A is an SEC rule issued in 1990 that modified a two-year holding period requirement on privately placed securities by permitting QIBs to trade these positions among themselves. Prior to this the holding period for such private stock was different. A 144A bond offering is a U.S. based offering, and typically is considered an alternative to the timely and costly initial public offering.
What Is Rule 144?
Rule 144 is a regulation enforced by the U.S. Securities and Exchange Commission that sets the conditions under which restricted, unregistered, and control securities can be sold or resold. Rule 144 provides an exemption from registration requirements to sell the securities through public markets if a number of specific conditions are met. The regulation applies to all types of sellers, in addition to issuers of securities, underwriters, and dealers.
Understanding Rule 144
Rule 144 regulates transactions with restricted, unregistered and control securities. These types of securities are typically acquired in unregistered, private sales or constitute a controlling stake in an issuing company. Investors may acquire restricted securities through private placements or other stock benefit plans offered to a company’s employees. The SEC prohibits the resale of restricted, unregistered and control securities, unless they are registered with the SEC prior to their sale, or they are exempt from the registration requirements when five specific conditions are met.
Five Conditions for Resale of Rule 144 Securities
• Five conditions must be met for restricted, unregistered and control securities to be sold or resold. First, the prescribed holding period must be met. For a public company, the holding period is six months, and it begins from the date a holder purchased and fully paid for securities. For a company that does not have to make filings with the SEC, the holding period is one year. The holding period requirements apply primarily to restricted securities, while resale of control securities is subject to the other requirements under Rule 144.
• Second, there must be adequate current public information available to investors about a company, including historical financial statements, information about officers and directors, and a business description.
• Third, if a selling party is an affiliate of a company, he cannot resell more than 1% of the total outstanding shares during any three-month period. If a company’s stock is listed on a stock exchange, only the greater of 1% of total outstanding shares or the average of the previous four-week trading volume can be sold. For over-the-counter stocks, only the 1% rule applies.
• Fourth, all of the normal trading conditions that apply to any trade must be met. In particular, brokers cannot solicit buy orders, and they are not allowed to receive commissions in excess of their normal rates.
• Finally, the SEC requires an affiliated seller to file a proposed sale notice, if the sale value exceeds $50,000 during any three-month period, or if there are more than 5,000 shares proposed for sale.
If the seller is not associated with the company that issued the shares and has owned the securities for more than one year, the seller does not have to meet any of the five conditions and can sell the securities without restrictions. Also, non-affiliated parties may sell their securities, if they held them for less than a year, but greater than six months, provided the current public information requirement is met.
Why Is Rule 144 Important?
As an employee, small business owner, or investor, you may own some restricted or control securities. These are usually given in the following situations:
• As a part of an employee benefits package
• As compensation for professional services
• In exchange for seed-money or start-up capital
• As a part of a merger and acquisitions (M&A) transaction
Rule 144 is important because it provides an exemption under which you can sell these securities in the public stock market without registering them with the SEC. Investors and shareholders in private offerings have the opportunity to resell their restricted securities, which makes them more valuable than if you held onto them indefinitely.
Who does Rule 144 apply to?
Rule 144 applies to:
• a non-affiliate shareholder who wants to sell their restricted securities
• an affiliate of the issuing company who wants to sell their securities (whether they are restricted or free trading) into the public market
Rule 144 does not apply to:
• sales in the public market that involve a brokerage firm
• private transactions, including sales, gifts, estate distributions, and pledges (but will apply when the recipient wants to sell the restricted stock to the public market)
Conditions of Rule 144
To sell your restricted or control securities to the public under Rule 144, you must meet five conditions. Note that although Rule 144 is not the only way to sell such securities, it is the most commonly used and provides a safe harbor for sellers.
You need to hold the securities for a minimum length of time (the holding period):
• If the company that issued the restricted securities is a “reporting company” (subject to the reporting requirements of the SEC), the holding period is at least 6 months.
• If it is not a reporting company, then the holding period is at least 12 months.
• The holding period begins on the date the buyer pays for the securities.
• If you received the securities as a gift from an affiliate, the holding period began when the affiliate acquired them, not on the date of the gift.
This holding period only applies to restricted or control securities — not securities purchased in the public market, which are not restricted. However, if an affiliate purchases non-restricted securities on the public market, those shares become control securities, and their resale must meet the conditions of Rule 144.
Free Initial Consultation with Lawyer
It’s not a matter of if, it’s a matter of when. Legal problems come to everyone. Whether it’s your son who gets in a car wreck, your uncle who loses his job and needs to file for bankruptcy, your sister’s brother who’s getting divorced, or a grandparent that passes away without a will -all of us have legal issues and questions that arise. So when you have a law question, call Ascent Law for your free consultation (801) 676-5506. We want to help you!
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506
Ascent Law St. George Utah Office
Ascent Law Ogden Utah Office
— Ascent Law (@AscentLaw) August 23, 2022